Problem 11 "If a firm has diminishing retur... [FREE SOLUTION]

Chapter 7: Problem 11

"If a firm has diminishing returns to labor over some range of output, it cannot have economies of scale over that range." True or false? Explain briefly.

Short Answer

Expert verified

The given statement is false. Even if a firm has diminishing returns to labour, it can still have economies of scale over that range. Because one governs how output reacts with change in input, in this case, labor and the other looks more at how cost reacts as production changes. They illustrate different aspects of the production process. Hence, it is possible to have both occurring at the same time.

Step by step solution

Understand the Concept of Diminishing Returns

To start, it's essential to understand that diminishing returns to labor signifies a situation where, upon increasing the number of laborers, the output or return increases but at a declining rate. This tends to occur when labor oversaturation is observed, and further addition does not contribute significantly to production.

Understand the Concept of Economies of Scale

Next, it's critical to comprehend that economies of scale occur when a corporation or business experiences a decrease in the average cost of producing per unit as their output volume increases. This phenomenon indicates efficiency in production.

Analyze the Relationship

Economies of scale refer mainly to how cost reacts as production changes, while diminishing returns refer to how output is affected by changes in input, in this case, labor. Although they are interrelated, they govern different aspects of the production process. Thus, it is possible to have both occurring simultaneously, since the reduction in the average cost (economies of scale) can happen even with diminishing returns of additional labor, as long as the cost of production per unit continues to decrease with increase in output. Hence, the statement given in the exercise is false.